The return of the interest-only mortgage

Interest-only lending is making a tentative come back. Natalie Stanton looks at what's changed and asks whether you should be tempted.

There's one mortgage product that took more blame for inflating the pre-2007 housing bubble than perhaps any other the interest-only mortgage. An interest-only mortgage, as the name suggests, involves taking out a loan to buy a property, but only repaying the interest each month, and none of the capital.That keeps the monthly repayments lower, so increases immediate affordability.

In theory, you should have a plan in place to pay off the capital at the end of the mortgage term. In practice, certainly before the financial crisis, many borrowers crossed their fingers and hoped that house price and wage inflation would render the question irrelevant. That led the CEO of the Financial Conduct Authority (FCA) to describe these products as a "ticking time bomb" a few years ago.

As a result of the financial crisis and the regulatory tightening that followed in the form of the FCA's Mortgage Market Review the loans all but went extinct. A quick glance at the figures tells the whole story. Before the credit crunch, in 2006, there were 75 lenders offering interest-only loans. By 2013, this tally had shrunk to just 12, according to data from Moneyfacts.

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However, interest-only lending is staging a comeback, partly as a result of competition for business. Now, just two years later, the number of lenders offering these types of loans has almost doubled to 22, having "woken up to increased demand", says Simon Read in The Independent.

It's easy to see why interest-only might be an appealing prospect for many borrowers. As well as reducing monthly payments, it offers more flexibility for those whose income is more irregular the self-employed, for example, or people who earn substantial bonuses as part of their salary. But while criteria are loosening up, this is still far from being back to the days of the pre-2008 easy credit bonanza.

For a start, you will need to have a "credible" strategy in place for paying back the capital at the end of the loan period. Most lenders are reluctant to let you rely on house price appreciation alone, which is probably a good thing, given the uncertain state of Britain's housing market (in London at least).

So if you're interested in taking out an interest-only loan, or switching to one, expect to face some tough questions not only relating to your income and spending, but assessing how you'd cope in the event of rising interest rates, for example. And many of the loans are aimed primarily at existing borrowers who have plenty of equity in their houses already the days when you could borrow 100% on an interest-only basis have yet to return.

If you're interested, Barclays/Woolwich and Leeds Building Society could be a good place to start. Both have recently amended their interest-only lending criteria, notes The Times, allowing borrowers with a 25% deposit to use the sale of the property to pay off the loan.

Natalie joined MoneyWeek in March 2015. Prior to that she worked as a reporter for The Lawyer, and a researcher/writer for legal careers publication the Chambers Student Guide. 

She has an undergraduate degree in Politics with Media from the University of East Anglia, and a Master’s degree in International Conflict Studies from King’s College, London.